Opinion: Deutsche Bank’s stock is a contrarian’s dream investment

The German bank resembles U.S. banks eight years ago, which rebounded after hitting rock bottom

Jasper Juinen/Bloomberg

The biggest problem for Deutsche Bank is that the U.S. Department of Justice wants to fine it for its role in creating asset-backed securities that contributed to the 2008 financial crisis. That might cost the bank $5.4 billion.

For a moment recently it felt like déjà vu all over again, to steal a line from Yogi Berra.

Fears circulated about a major bank failure that would create systemic risk and sink the economy of an entire region.

It sounded a lot like 2008-2009. Except the region was Europe and the bank was Deutsche Bank AG
DB, +2.47%
not the U.S. and Lehman Brothers.

This kind of flashback can send shivers down your spine. But depending on how you behaved during the crisis eight years ago, this flashback might also bring up some great memories.

After all, had you bought most any of the major banks after the worst of the financial meltdown, or any of the subsequent mini-panics, you did well. The shares of U.S. banks that seemed destined for a meltdown back then — Citigroup Inc.
C, +1.04%
Bank of America Corp.
BAC, +1.07%
or even J.P. Morgan Chase & Co.
JPM, +1.62%
— are up twofold, threefold or more.

Now, you’re getting another shot with Deutsche Bank. And you should take it.

Sure, there are risks. There are more shoes to drop at Frankfurt, Germany-based Deutsche Bank. And it won’t be an overnight success as an investment. But Deutsche Bank is not going to blow up and disappear, as some investors fear. And shareholders probably won’t get diluted to smithereens by a capital increase to shore up the balance sheet either — another big worry.

Nonetheless, Deutsche Bank’s stock remains one of the most widely despised names in the market. This makes it a contrarian’s dream. Let’s take a look at six reasons to buy Deutsche Bank now.

Virtually all sell-side analysts are negative on this bank. Most report ratings of “sell” or “hold,” the latter of which is typically a code word for “sell” on Wall Street. The median price target is $9.97, according to Thomson Reuters. In other words, the analysts who cover this stock are predicting a decline of about 25% from recent levels of $13.39. Deutsche Bank already has sunk 44% this year.

Of course, sell-side analysts are often right. But you have to ask yourself: With analysts so negative, how many investors are left to turn negative and sell, putting more downward pressure on the stock? Not many. And if things start to go right, there are a lot of investors around to turn positive and get in.

Reason 2: The stock is incredibly cheap

All the big banks in Europe — like Credit Suisse Group AG
CS, +1.81%
UBS Group AG
UBS, +0.89%
ING Groep NV
ING, +2.93%
and Banco Santander SA
SAN, +2.05%
— look cheap because they are trading below book value. These banks trade for 0.6 to 0.95 times book because of worries about the European economy and exposure to dud loans. But even compared to them, Deutsche Bank looks really cheap. It trades for only 0.24 times book value.

Reason 3: The bank is losing money, but things could improve

A big problem for banks on the continent is that the European Central Bank (ECB) has pushed interest rates into the negative zone to try to spur growth.

“It is hard for a bank to make net interest margin when you have negative rates,” says Brian Frank, manager of the Frank Value Fund
FRNKX, +0.25%

But what if growth actually does improve in Europe? That would not only ease worries about loan-growth potential and exposure to bad loans at Deutsche Bank, but it would also have the ECB scaling back negative rates.

No one knows for sure when, or possibly if, Europe will ever get out of the doldrums. But for the first time during this recovery, all of the major economic regions of the world are in stimulus mode. So there’s a new dynamic that could be good for global growth, including in Europe.

Japan has backed away from an earlier hesitancy on stimulus. And China and Europe have reversed policies to slow growth that were in place at various points in recent years, post-meltdown.

“For the first time in this recovery, nearly all global economic policies are aligned,” says James Paulsen, an economist who is the chief strategist at Wells Capital Management. That makes the odds of a synchronized global economic bounce far more likely than many investors think, he says.

Reason 4: The risk-reward may be in your favor

“Clearly the market is telling you Deutsche Bank assets are worth less than their stated value,” says Frank, at Frank Value Fund, referring to the bank’s steep price-to-book discount of 0.24.

But the discount also incorporates a lot of fear and loathing toward Deutsche Bank. This could ease as European economic growth and the bank’s profitability improve, and as the bank takes steps to bolster its strength. The bottom line here is you have the potential for a three-bagger or more (200%-plus gain) if the stock trades back up above book value.

Reason 5: Europe isn’t going to let Deutsche Bank fail

Probably for political reasons (many Germans are weary of bank bailouts), the government of German Chancellor Angela Merkel has reportedly said it won’t be coming to the rescue of Deutsche Bank. But, in reality, it’s unlikely the government would let the bank go under. And if Germany did step aside, Europe would step in and help.

“We believe that these statements may reflect political posturing by Merkel or her supporters in the face of a heavy schedule of elections later this year and in 2017,” says Christopher Whalen, senior managing director at Kroll Bond Rating Agency (KBRA). “There is no way the ECB, the German government, or the Fed are going to let a bank this size go under. It is just not going to happen.”

Reason 6: Deutsche Bank probably will have to raise capital, but it might not be as bad as you think

The biggest near-term problem for Deutsche Bank is that the U.S. Department of Justice (DOJ) wants to fine it for its role in creating asset-backed securities that contributed to the 2008 financial crisis. That might cost the bank $5.4 billion. The bank may also face big fines for money-laundering in Russia, and for manipulation of foreign-exchange markets.

Deutsche Bank already has a thin capital cushion. So these numbers seem scary. But any capital increase might not be as dilutive as a lot of investors think, for three reasons.

If the DOJ settlements with other banks are any guide, about a third of the fine might come in the form of “consumer relief” that involves no cash outlays, points out Goldman Sachs analyst Jernej Omahen, who has a “neutral” rating on the stock. (This could mean things like homeowner loan forgiveness or debt restructuring to prevent foreclosure.)

Deutsche Bank can sell assets such as Postbank, a savings bank, to raise funds.

Deutsche Bank is vulnerable, but not desperate. “We do not believe that Deutsche Bank faces any imminent danger of illiquidity or failure,” says Whalen. “KBRA views Deutsche Bank as both financially stable and having more than adequate liquidity.” Whalen has an investment-grade rating on the bank’s debt. “They are not desperate,” he says. Whalen offers no forecast on how dilutive any capital increase might be. But his overall assessment suggests the bank has room to wait, and that the funding might not dilute stockholders by an excessive amount.

Your biggest problem might be boredom

A big risk is that investment shops or depositors pull their funds because they become worried about Deutsche Bank’s solvency, notes Frank. At that point, failure of the bank turns into a self-fulfilling prophecy. But “a bailout or a capital raise would be a way to shore up confidence in the bank and stop a run” on it, he says.

Barring that kind of crisis, though, you can expect a slow-motion recovery for Deutsche Bank and its stock.

“Europe has some work to do to shore up its banking system, and it is not going to go away soon. They tend to kick the can down the road,” says Frank.

Or, as Whalen puts it: The biggest danger investors face with large European banks is that they get “bored to death” waiting for a turnaround. This isn’t just a joke. Boredom is a significant risk in investing, because it can make you sell a stock right before a big move up. It’s happened to me.

At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested JPM, C and BAC in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program.

Michael
Brush

Michael Brush is a Manhattan-based financial writer who publishes the stock newsletter Brush Up on Stocks. Brush has covered business for the New York Times and The Economist group. He attended Columbia Business School in the Knight-Bagehot program.

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